The Great Recession swept across California, leaving behind record unemployment, empty homes and stores, and broken projects strewn across the landscape.

But this dark cloud has a silver lining. Lower land values and construction costs have created advantageous conditions for owners to upgrade assets while the market’s reduced rents have encouraged retailers to open new stores.

As a result, high-barrier submarkets in San Diego, Los Angeles and San Francisco are experiencing increased demand by retailers, who want to lock down deals before bargain rents and construction prices disappear.

“Lots of tenants are looking for well-located properties or land, values are flat but holding, and anything that’s well-located doesn’t last long,” says Tony Villaseñor, senior vice president for retail in the San Diego office of Santa Ana, Calif.-based Grubb & Ellis Co.

Encino, Calif.-based Marcus & Millichap Real Estate Investment Services notes that effective rents have dipped on average between 2.4 percent to 4.5 percent in San Diego, Los Angeles and San Francisco, compared to 2009. That’s brought rents to a level where retailers are more willing to do deals.

Moreover, owners say construction costs are down up to 25 percent throughout the state, making it a good time to break ground or redevelop dated centers. The lower construction costs mean that developers can accept the market’s new lower rents and still building projects that turn a profit.

Consequently, California’s dominant markets are seeing signs of renewed development and redevelopment activity. Broken projects are getting a second chance, new centers are rising, empty boxes are disappearing, malls are getting makeovers and vacancy rates are declining.

For example, Walter Pagel, senior vice president for retail in the Newport Beach office of Grubb & Ellis Co., says that unfinished, bank-owned projects in Chino and Moreno Valley recently were bought up on the cheap by developers.

This allowed the stalled projects to move forward because the new owners bought them at a low enough price that they can afford to lease up the property at rents of $21 per square foot.

In contrast, the projects stalled because the original developers had been asking for rents of $25 per square foot in order to generate cashflow necessary for healthy returns. Those rents were too high for prospective tenants.

Financing feats

Even lenders are coming back to help fund projects, albeit cautiously. Banks are scrutinizing rents to ensure projects pencil and are taking a new look at pro formas of stalled projects to decide if they make sense now, notes Morgan McEvoy, vice president of retail services in Los Angeles for Seattle-based brokerage firm Colliers International.

Signed leases increase a property’s value, often providing ample equity to secure a loan, even at today’s 50 percent to 60 percent loan-to-value requirement, he explains. For instance, ground leases for two Fresh & Easy Neighborhood Markets and a CVS pharmacy enabled two of McEvoy’ clients to obtain loans for renovating 50-year-old strip centers.

Santa Monica, Calif.-based developer Watt Cos. used a similar strategy to secure $15 million in financing to renovate and expand an old strip center in Harbor City, an ethnically diverse community in the Los Angeles South Bay.

This center is getting a complete makeover, thanks to the loyalty of three national tenants—L.A. Fitness, Ross Dress For Less and Falles Paredes. All three signed leases in 2007 and maintained their commitments to this location through the recession, notes broker Chris Wilson, president of Los Angeles-based Wilson Commercial.

A growing pipeline

New Lowe’s stores in San Francisco and Concord account for about half of new space rising in the Bay Area. Significant projects, however, are getting under way throughout San Francisco, including CityPlace, the Fourth Street shopping district at North Mission Bay, Alameda Landing and a new transit-oriented development downtown.

CityPlace recently won city approval after being stuck in the entitlement process for six years, notes Ross Portugeis, a retail broker in Colliers’ San Francisco office. Located on Market Street in downtown San Francisco, this project, by local developer Urban Realty Co. Inc. and Commonfund Realty Inc., a Connecticut-based investment manager, will replace several vacant buildings with 350,000 square feet of “sexy, glass-walled retail space,” he says.

The drama is not completely over, however. An appeal of the CityPlace environmental impact report has been filed and a hearing was slated for early September.

Another big San Franciso project is the latest iteration of Mission Bay. In terms of retail, a joint-venture of locally-based Farallon Capital Management, the city and Mission Bay Development Group LLC have plans to create a 100,000-square-foot shopping district in the development’s residential sector.

“In five to 10 years this will be the heart and soul of the community,” says Kelley Kahn, Mission Bay project manager for the city’s community redevelopment agency.

In addition, there is Alameda Landing, a 97-acre, mixed-use project by San Francisco-based Catellus, a division of global REIT ProLogis, that is scheduled to break ground in 2011.

The project, which includes 300,000 square feet of retail, 400,000 square feet of office space, 300 residential units, a hotel and a senior housing facility, will be developed in phases, beginning with residential, notes Sean Whiskeman, vice president of retail operations for Catellus.

Also under construction is a new one-million-square-foot Transbay Transit Center. With ground-floor and concourse-level retail, the center will serve passengers on the region’s 11 transit systems and future Caltrain high-speed rail. The transit plan calls for transforming the adjacent area to a transit-oriented development with 2,600 homes, 100,000 square feet of retail, and three million square feet of office space.

Meanwhile, two lifestyle centers account for most of the retail space under construction in the Los Angeles area.

Meanwhile, two lifestyle centers account for most of the retail space under construction in the Los Angeles area.

Further south, new Lowe’s stores account for about half of new retail space rising in San Diego County. “But lots of tenants are looking around for well-located properties or land,” Villaseñor says. “And there’s no shortage of tenants looking for deals in neighborhood centers,” he adds, noting that insurance companies and pension funds are back in the real estate market and are investing in this asset class.

The real growth area for San Diego, however, is in the downtown market, because the city has required residential projects to have 20 percent of their space devoted to retail.

... story for San Diego for the last two years because of all the residential development,” notes Villaseñor. “Space that sat vacant for two years is now leasing up,” he says, noting all major retailers want to be there.

Retail repositioning

With the mixed-use synergy downtown, Australian limited property trust Westfield is expanding downtown San Diego’s Horton Plaza, with plans to add office and residential towers as well as 300,000 square feet of new open-air retail space.

In fact, a number of developers are taking advantage of the recession’s deep construction discounts and slower foot traffic to modernize major assets throughout the state. Besides Horton Plaza, Westfield is upgrading three other malls in San Diego County with open-air retail components.

“Ongoing reinvestment positions Westfield centers to prosper in good times and be resilient through sluggish, negative economic cycles,” states Katy Dickey, executive vice president of corporate communications for Westfield. “Although we are certainly sensitive to the current economic environment, we have a much longer view–two, five, 10 years ahead.”

Westfield is also renovating, expanding and adding open-air retail components at regional shopping centers in Culver City, Valencia, Arcadia and Van Nuys in the Los Angeles area, as well in Sacramento, Roseville and San Jose.

Catellus is upgrading retail centers in the San Fernando Valley and affluent Orange County community of Newport Beach, as well as a regional shopping center in Fremont, which is in the Bay Area.

“During this so-called bow in the market, we’re looking for ways to create value, while waiting for a new ramp up in the development cycle,” notes Sean Whiskeman, vice president of retail operations for Catellus.. “The 20 percent to 25 percent construction savings over the height of the market helps to overcome the pullback in rents.”

The big story in west Los Angeles is the de-malling of Santa Monica Place by locally-based Macerich. The formerly enclosed mall, which was closed in 2008 and gutted down to the steel beams, reopened in early August as an open-air, regional shopping center, configured to transition seamlessly into the adjacent Third Street Promenade.

Besides Santa Monica Place, Macerich is also upgrading and expanding malls in Los Cerritos and Lakewood in the Los Angeles area, and South Bay, San Rafael and Walnut Creek in the San Francisco Bay Area.

“We’re using the economic downturn to focus on making assets stronger,” confirms John Genovese, Macerich executive vice president for development.

“We’re focusing on our best assets, where we know there will always have demand and barriers,” he adds, noting that the company is also preparing for future growth. “We’re determining where the opportunities are and getting entitlements to enhance properties, so we’re ready to go when the market is right and retailers are ready.”

Public-private partnerships

Another factor driving development in the current market is the desire by governments to clean up industrial sites and blighted, crime-infested neighborhoods and create vibrant downtowns and transit-oriented development provides untold opportunities to do that.

Financial incentives offered by governments, which may include access to free or low-cost land, tax-incentive financing, publicly financed bonds and federal redevelopment funds, can help projects pencil, attract investors and secure financing.

Cities also are helping developers clean up brownfield sites for redevelopment. Armando Aguirre, senior vice president for Collier’s Downtown Los Angeles retail group, points out that once cleaned-up, four- to 12-acre industrial sites are attractive to retailers like Lowe’s, Costco and other large users. Plaza Pacoima is a prime example of this kind of development.

Plaza Pacoima, a 220,000-square-foot power center anchored by Costco, Best Buy and Lowe’s, opened earlier this year in Pacoima. This impoverished, predominately Hispanic community of 60,000 in the San Fernando Valley has the highest rate of unemployment in Los Angeles County.

This public-private project, which was developed by Primestor Development Inc., in partnership with Prudential and the Los Angeles Community Redevelopment Agency, replaced a former industrial eyesore with green development. The project created1,000 construction and permanent jobs and is expected to generate $2 million in tax revenue for the city.

Cities are incentivized by social and tax benefits of redevelopment, but also provisions of AB 375. AB 375 offers cities a road map for attaining California Climate Change Act greenhouse-gas-reduction goals by halting urban sprawl.

The law encourages cities to adopt a general plan with a Sustainable Communities Strategy (SCS) that requires new development to be near transit or clustered with existing development.

Cities are not required to adopt the SCS, but only those that do will be eligible for a share of the state’s $6 billion annual transportation budget. The law also exempts qualifying smart-growth projects from the state’s onerous environmental review process.

Plaza Pacoima has something else going for it, which is that it is aimed at an underserved Hispanic population surrounding the site in addition to providing amenities for other shoppers. Centers, like this, designed to cater to ethnic populations while also serving a broader audience, are taking shape in multiple parts of the state.

“High-density Hispanic markets are seeing key power players going in to fill the void of brand-name retailers,” says Aguirre. He notes a shift away from ethnic-oriented centers in Hispanic communities. “Hispanics want the same things they see in other neighborhoods.”

Primestor is a pioneer of retail development in Southern California’s underserved, Hispanic communities. In addition to Pacoima, it also has opened another successful retail center within the last 18 months.

Plaza Alameda, an 18-acre, 270,000-square-foot center, anchored by Ross Dress for Less, Marshall’s, Petco and CVS Pharmacy, is located in the 95 percent Hispanic community of Walnut Park, south of downtown Los Angeles. The center has 1.1 million people living within a five-mile radius.

“These centers are home runs because there was nothing like it there,” Aguirre says. “What’s important is these projects made big strides in the sustainability of these communities,” he adds, noting they create desperately needed jobs, provide a tax base for city services, keep money circulating within the community, and will initiate more retail development.

Tenant tango

What’s making all of the development and redevelopment activity possible, however, is interest from all kinds of retailers to expand in California.

Banks are the most active small tenants, scouring urban landscapes in all three top markets for buildings in the 4,000-square-foot to 5,000-square-foot range. Chase is the most aggressive, but Bank of America, Wells and Union Bank also are expanding, local brokers say.

Other fast growing segments include fast food restaurants and quick service chains. Carl’s Junior, Jack in the Box, McDonalds, Del Taco, In & Out Burger, Five Guys Burgers and Fries, among others, are all expanding.

And gas station operators are also on the lookout—especially for sites they can purchase rather than lease—notes Jim McMasters, director for retail in Colliers’ Walnut Creek office. Therefore, they are competing with CVS and Walgreens for well-located corner sites in the 1.0-acre to 1.5-acre range.

However, Solomon Ets-Hokin, senior vice president for leasing and retail development in Colliers’ Oakland office, notes that it is difficult to do deals with discount stores in high-barrier, urban markets, because they are inflexible on how much rent they are willing to pay.

In Oakland, for instance, the cost to divide vacant boxes adds about $5 per square foot to annual rents. Discounters are willing to pay a maximum of $15 per square foot, while owners need $20 per square foot to make these deals pencil out, he says. According to Marcus & Millichap, the average retail rents in San Francisco, San Diego and Los Angeles markets are above $23 per square foot.

Fresh & Easy, a 15,000-square-foot neighborhood market concept launched in 2007 by United Kingdom-based Tesco, is the most aggressive, with more than 80 stores under way throughout the state.

Traditional grocers are engaged mainly in renovating existing assets. But Safeway is aggressively redeveloping empty boxes in the Bay Area, dividing them up to create space for a grocery and inline shops, notes Ets-Hokin. The company is redeveloping a former Target and two Mervyn’s stores in the Bay Area, as well as a 15-acre, ground-up project that includes a 65,000-square-foot grocery and 40,000 square feet of shops and pads.

Target Corp. is also scoping spaces. Along with Home Depot, it is ramping up its expansion plans to help appease Wall Street. Both firms have laid out ambitious expansion goals for the period between 2012 and 2014, notes Orange County-based Jeff Moore, senior managing director of retail for the western division of CB Richard Ellis.

Target will co-anchor the $180-million, 330,000-square-foot expansion at Westfield Culver City regional shopping center (formerly Westfield Fox Hills), along with Best Buy and Gold’s Gym. Additionally, a former Home Depot Expo store at East Bay Bridge Shopping Center in San Francisco is being repositioned for Target.

Target also has its eye on two sites in San Francisco’s urban core, at Westfield’s Metreon on 4th Street and a former Mervyn’s on Geary Boulevard in the Western Addition, notes Portugeis. He says that historically the city has been unfriendly to big-box retailers, mostly because of parking issues. But with recession economics, the city appears to have had a change of heart.

Signs of a more lenient attitude toward big boxes include approval of a plan to replace a lumberyard with a Lowe’s store, according to Portugeis, who notes that Home Depot had tried for several years to redevelop this site, but finally gave up due to the city’s resistance.

Additionally, Petco is launching Unleashed, a boutique concept that specializes in natural, organic, and higher-end pet products. Meanwhile, Staples is introducing a copy-print concept to compete with FedEx Kinko’s.

With high demand for empty boxes left by Mervyn’s, Circuit City, and Linens ‘n Things, available spaces are disappearing. Santa Monica-based developer James Maginn, president and CEO of Watt Cos. notes that his firm had seven empty boxes vacated in 2009, but now has found takers for all but two of those spaces.

Big-box retailers also are active in dense, ethnic communities, which historically have been ignored by national chains.

In the end, it all makes for an encouraging picture in California going forward. Brokers are optimistic that in spite of the state’s economic troubles, there remains a good market for retail properties. And most experts are expecting the recovery to continue to gain strength through the end of 2010 and into 2011.